Since the year 2000, public trust and confidence have been rocked by catastrophic business failures, financial reporting restatements, the dotcom bubble, corporate scandals and now, by the global credit crisis. It is easy to understand why only 22 percent of Americans have faith in the financial system and financial reporting according to a recently launched financial trust index. ("Wall Street Excess: Looting Stars," The Economist, Jan. 31, 2009)
In response to the financial and ethical bankruptcy erupting all around us, calls for tighter regulation will only mount. However, no regulation, rule, law, standard or principle alone can protect investors and maintain the integrity of the markets. What really matters is people doing the right thing and holding themselves accountable for the consequences of their actions. From this universal truth we can begin to improve business reporting by making it more transparent.
Today's credit crisis is a harsh reminder that our financial reporting model, created more than 70 years ago during the Industrial Age, does not provide enough of the information necessary to allow investors to understand and assess business risks and performance. This "information gap" requires a fundamental rethinking of the information that corporations should be disclosing to keep investors properly informed about corporate financial prospects. Given the cost of the credit crisis, can the United States and indeed
the entire international community afford to ignore the need to enhance business reporting?
Grant Thornton LLP CEO Edward Nusbaum served on the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR). Our firm heartily endorsed the recommendations of the committee, calling its report "a catalyst for future action to make public company financial reporting more relevant, accessible and reliable."
CIFiR's August 2008 report included a number of recommendations for improving financial reporting. One recommendation, "Disclosures of KPIs and Other Metrics to Enhance Business Reporting," urged the SEC to "encourage private-sector dialogue, involving preparers, investors (including analysts), and other interested industry participants, such as consortia that have long supported KPI-like concepts, to generate understandable, consistent, relevant, and comparable KPIs...."
Key Performance Indicators (KPIs) are measures used to evaluate progress made toward an objective. The most effective KPIs are not only leading indicators of performance, but also provide insight into intangible factors such as intellectual assets, human capital and customer relationships. For example, would it help Reno investors to be able to assess qualitative factors such as strategy, innovation, people and customer loyalty? What about market share, leadership, technological change, R&D, brand or patents? Surely, providing KPIs and informative narrative about all of these parameters would enable or enhance assessment of the quality, sustainability and variability of a company's cash flows and earnings. However, KPIs are generally not found in existing U.S. financial reports.
U.S. CFOs also agree that our financial reporting system needs an overhaul. In a Grant Thornton LLP survey of nearly 700 U.S. CFOs and senior comptrollers conducted recently, 73 percent said that financial reporting was too complex to be understandable by investors, and 84 percent would support supplementing financial statements with nonfinancial measures that provide more relevant information about their organization and its value drivers.
For the greater good of the capital markets, Grant Thornton encourages the business community to join us in our efforts to bring CIFiR's recommendation to life. The Enhanced Business Reporting Consortium (EBRC), of which Grant Thornton is a founder, and Gartner, Inc., are collaborating to engage business executives, financial analysts and investors in a study to research which KPIs are most important to analysts and investors. This private-sector initiative to develop KPIs is necessary to ensure that capital market participants have a solid understanding of exactly what is being measured. This effort will also ensure that agreed-upon KPIs permit direct comparison between companies within an industry.
A scan of corporate annual reports typically reveals a presentation or discussion of market share. Defining market share is no simple task. Do all food and beverage companies define and measure market share in the same way? Is there consistency in defining market share across the financial services and consumer goods sectors? The EBRC/Gartner collaboration will produce accessible definitions of performance indicators definitions that explain both the components of a metric and how that metric is calculated.
The development of KPIs is only one element needed to create a new global framework for business reporting. The highly beneficial results of these efforts will translate to robust capital markets, markets that thrive on a steady flow of timely, comprehensive, relevant and reliable information.
Could KPIs have prevented the present equity and credit market trauma? Probably not, but it is Grant Thornton's goal to work continually on behalf of the investor to provide clear and relevant information that can be relied upon for making informed decisions.
KPIs represent a major leap forward in doing so.
Brian Wallace is Reno office managing partner with Grant Thornton LLP. Contact him at 786-1520 or through grantthornton.com.
